Home under construction? You have mortgage options

Swiftly rising mortgage rates have caught one group of borrowers in an especially tight bind: those whose houses are under construction.

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Many people bought yet-to-be-built houses in the spring, when fixed-rates on 30-year mortgages were under 6 percent and even under 5.5 percent. They assumed that rates would remain steady for another six, nine or 12 months, when construction would be completed and they could close on their permanent mortgage loans.

Instead, mortgage rates rocketed upward by 1 percentage point from late June to late July. The rapid rise worries people who can't close on their home loans until late this year or sometime next year.

Three main options
For these people, the options include floating the rate until close to closing day, when they can lock without paying a fee; paying now for a long-term rate lock, or getting an adjustable-rate mortgage. All of the options involve trade-offs.

Lenders offer a wide range of rate locks. Many will let borrowers lock the current rate up to 30 or 60 days in advance, with or without a fee. Most lenders will allow borrowers to lock three months in advance. Some lenders let borrowers lock rates for six, nine or 12 months for a fee, with the amount varying by lender and type of loan. With long-term locks, the borrower doesn't lock the current rate, but buys a cap beyond which rates can't rise in the future.

For example, if the current rate is 6.25 percent, a borrower might pay a point (1 percent of the loan amount) to cap the rate at a maximum of 6.75 percent six months from now.

"As rates rise, it's not really a matter of walking away from the deal, but looking for ways to cut costs," says Amy Huff, whose house in central Iowa should be ready late this year. She and her husband have two young children. They sold the house they owned for eight years and are living in an apartment for now.

Around mid-September they should be able to lock at the current rate without paying a fee. Or, before then, they could pay a point -- about $2,000 -- to cap their rate at about 7 percent. That's a disappointing possibility because the prevailing rate on a 30-year fixed-rate loan was about 5.25 percent when they "jumped into this house project with both feet (may have actually been more of a cannonball into the deep end)," Huff writes in an e-mail interview.

"In the end, it will probably mean the difference between me staying home with my 1-year-old or going back to work," Huff says. "That's a choice we'd hoped we wouldn't have to make, but that's life, and millions of people have to make much tougher decisions every day."

The Huffs are floating for the time being, guiltily rooting for bad economic news that might depress mortgage rates far enough to warrant locking for the long term, even if it costs $2,000.

Long rate locks in demand
"Consumers are worried," says Tom Meyer, president of Homebuilders Financial Network. "They're saying, 'Gosh, good rates continue to rise. My home won't be available for six months.' So we're seeing huge consumer demand for long rate locks."

Meyer's company staffs and operates in-house mortgage companies for 31 large builders, including Beazer Homes. About 40 percent of HFN's borrowers are first-time home buyers -- people who are new to the lingo and complexity of mortgages. HFN's brokers have always encouraged borrowers to take long-term rate locks, both to protect borrowers from rising rates, and to protect builders from having deals fall through because of the effect of rising rates on borrowers.

Until June, borrowers were leery of getting long-term locks for fear that rates would continue to fall and they would miss out on rock-bottom rates. The psychology has changed since June because rates have been rising. Now home buyers worry about how they will be able to afford their monthly payments if rates rise to 7 or 7.5 percent.

Getting a long-term rate lock, even if it costs a point or two, "is like an insurance premium," says Ellen Bitton, president of Park Avenue Mortgage in New York. "It might help you sleep better at night so you know your worst-case scenario."

Floating -- the gambler's choice
Some borrowers don't mind uncertainty. They don't lose sleep over the prospect of rising interest rates. "If you're not afraid of where rates will be and you're a gambling kind of man or woman, then you say whatever will be, will be" -- and you float, Bitton says.

Home buyers always have the option of getting adjustable-rate mortgages, or ARMs. Many choose hybrid ARMs, which have an initial fixed rate that lasts for a few years (often five years, but sometimes three, seven or 10), then adjusts annually thereafter. ARMs are especially attractive to buyers who know they will sell the house in a few years.

"Since the end of May until now, we've seen a sharp increase in ARMs because of the uptick in interest rates," says Garth Graham, senior vice president for ABN-AMRO, one of the nation's largest mortgage lenders. "Our ARM volume is now 40 percent, where it was less than 20 percent just two months ago."

ARMs' benefit
The benefit of getting an ARM is that you can get a loan at an affordable rate now and refinance later.

But keep in mind that today's rates, although higher than they were just a month or two ago, are still attractive.

"Even at 6.5 and 7 percent, interest rates are still historically low," Bitton says. "Twenty-two years ago, fixed rates were 18.75 percent."

Just to keep things in perspective.